Two Concepts of the Output Gap

Two alternative concepts of the output gap, Keynesian and monetarist, can be distinguished. When they use the phrase, economists should make clear which concept is under discussion. The first concept, developed by Okun in the early 1960s, defines the output gap relative to a full employment notion of output. It was a standard part of the Keynesian policy toolkit in the 1960s and 1970s, and was associated with the active use of fiscal policy to promote full employment. As stated by Okun, the gap takes only positive values and these values rise with unemployment. The second concept, which is derived from Friedman’s 1967 accelerationist hypothesis, defines the output gap relative to the natural-rate-of-unemployment level of output. It takes both positive and negative values, and, following the lead of the international research organizations (the OECD and the IMF), an above-trend level of output is said to define a ‘positive output gap’ and a beneath-trend level a ‘negative output gap’.